06. Birth of a ChArtist

I purposely capitalized the letter “A” in the word “Chartist” for a reason. Although chart analysis is a science as there is a great deal of math, and psychology behind the charts, I am convinced that for one to see the fine footprints of what is going on in the market and where it is going, one has to draw up from his innate artistry of reading the charts. Thus, the generation of the charts is science but its interpretation is art.

Since January 2011, I have already invested 73% of my funds without even analyzing the charts. I only followed two rules. First is to buy stocks of companies with increasing earnings per share but which stocks are already at the bottom of the chart. Yes, I did look at the charts but did not analyze them. Second is to buy my favourite stock every time its price loses 15% of its previous high. The first rule is my own version of investing in undervalued stocks which I plan to hold long enough until its price shoots in one (1) to three (3) years. I figured that if the price is already low there is nothing for it to go but up. The second rule is my own version of a trading plan. I figured that stock prices in the past weeks simply go up and down in rhythmic fashion. Therefore, I reasoned that if it goes down 15% and moves up again I will be riding the waves in profit. Well, it did not turn out as I expected. The stock market has been on a downtrend since January and I am losing! Something is wrong and something has got to be done. I found it in technical analysis.

The first technical tool I learned is Trendline Analysis. I started drawing lines (red line on chart) by connecting lines between the highs and lows of the chart (see Exhibit 1). I noticed that even if the price goes up and down in time, its general direction is going down. Second, the distance between the high line and the low line is decreasing. The market is thus bearish (downward direction of the lines) and trading downtrend is becoming more risky as it is almost impossible to profit as you go lower down the trend (distance between points along the line is getting narrower). A good advice I got from reading the book “Market Wizards” is to never buy stocks on a downtrend as you will just add one losing position after another. Cost averaging going down is a wrong idea!

The second technical tool I learned is momentum of the downtrend or uptrend.  Momentum tells you whether the price trend is accelerating or decelerating. If it is accelerating, the price will definitely establish a new low or new high that is far greater than the previous one. I started drawing lines (dark blue lines on chart) alongside the downward movements (Exhibit 2) and you will notice that the lines are getting steeper as we go from left to right. This tells that the market is in a more bearish mood every week. During this period, the successful revolt in Tunisia precipitated another revolt in Egypt. At the same time, rumours of higher interest rates due to inflation pressures are constant fodder in business news. I can read this in the online newspapers as well as the major broadcast networks around the world. Had I done this kind of analysis earlier, I could have held off on buying stocks. 

The third technical tool I learned is resistance and support. I still do not have a very good grasp as to how this develops but my own understanding is that if the market goes sideways for days that is where the resistance (if market is going up) and the support is (if market is going down). The line chart does not give a very  good picture when it comes to resistance and support and so I made my own candlestick chart which by the way is the fourth technical tool I learned. Using the available data from PSE website on the charts above, I created the candlestick chart on Exhibit 3 and draw lines (aqua green horizontal lines on the chart) along the bottom portion of the prices where they tend to go sideways. You will notice that if the next candlestick crosses the line, you will certainly see the price in the succeeding days to move even lower. The support and resistance thus gives you indication at what price you enter or exit the market. But of course, you have to temper it with the general trend. Margin traders will probably call the shots every time they see the price crossing the support or resistance lines.

The fourth technical tool I learned is the candlestick analysis courtesy of the videos posted by Lance Biggs in his website http://www.yourtradingcoach.com/. The candlestick analysis shows patterns that signals a bearish or bullish reversal. This pattern must be confirmed with the next price move that supports the pattern. There are different types of patterns such as the morning star, hammer, dark cloud cover, among others. These are clearly discussed and demonstrated in Lance’s website and readers of this blog are encouraged to check it out. It is enough to note that those patterns are not yet seen in the downward trend in Exhibit 3 and therefore I can say with almost prophetic certainty that the downward trend will continue for a much longer time. How long? The Bollinger Band may provide an answer.

The fifth technical tool I learned is the Bollinger Band. The Bollinger Band (Exhibit 4) theorizes that stock prices move within a certain band regardless of the trend. Once the price touches the lower part of the band, expect the price to move up and vice versa. As long as the price movement stays within the band, you can expect the general price direction or trend to continue. As you can see in Exhibit 4, the price of this particular stock moves within a certain band and every time the price touches the lower part of the band, the price moves up and when it touches the upper band it moves down. At the lower part of the price movement, you can see that the price already touches the upper band and therefore we can expect the price to move down tomorrow. We can also see that this is going to continue until March.

However, a word of caution in drawing the band because I can also present an alternative band showing that the last price is touching the lower part of the band and therefore price is expected to move up. This is presented in Exhibit 5. To decide which exhibit presents the more accurate forecast, I will have to use the four other tools previously mentioned. Our trendline analysis shows that there is already a congestion (I do not know if I am using the right term) somewhere along the lower part of the trend. The momentum of the downtrend is also decreasing abruptly. However, the candlestick analysis has not yet shown that pattern of a reversal. What we are seeing is that there are more RED candlesticks signifying bearish sentiments than green candlesticks signifying bullish sentiments in the market. More importantly, in areas where the price moves sideways the green candlestick is easily overcome by a series of red candlesticks every time.

Today’s price (February 17, 2011) closes at P45.25 only a notch higher than yesterday’s close at P45.00. However, the volume today rises to 1,258,000 which is the highest recorded volume since I began monitoring this stock in January 2011. I can sense that an investment firm or mutual fund may be buying the stocks but I continue to be bearish. The reason is that the Arabian Peninsula is again rocked by protests in Bahrain, Yemen, Iran, Libya, and Jordan. Asian countries, with the exception of the Philippines, are also buying rice in large volumes due to perceived food shortages in the coming months. Domestically, the increase in remittances in 2010 can trigger inflationary pressures and I suspect that the BSP will be raising the interest rate in March. My personal assessment is that this is only a temporary uptick within the downward trend and that the price can potentially hit P30. But if the reversal presents, I will immediately buy this stock at P47.    

There definitely are more things to learn. I have heard of the Elliot Wave, the Random Statistical Index (RSI), the MACD among others and boy am I excited to learn this. I cannot wait for the Certification on Securities Specialist to start! Passing it will be my baptism.